U. S. SECURITIES AND EXCHANGE
      COMMISSIONWASHINGTON, D.C. 20549FORM 10-Q(X)
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
      OF SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended
      September 30, 2003(  )
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
      OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from
      __________ to __________Commission file number  0-26016PALMETTO BANCSHARES,
      INC.(Exact name of registrant as specified in its
      charter)South Carolina(State or other jurisdiction of
      incorporation or organization)
    
    74-2235055(IRS Employer Identification
    No.)301 Hillcrest Drive, Laurens, South
      Carolina(Address of principal executive offices)
    
    29360(Zip Code)(864) 984-4551(Registrant's telephone
      number)
    
    palmettobank.com(Registrant's web
  site)Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days. Yes X   No
      __Indicate
      by check mark whether the registrant is an accelerated filer (as defined
      in Rule 12b-2 of the Exchange Act).  Yes X   No __Indicate the number of shares outstanding of each of the issuer's classes
      of common stock, as of the latest practicable date.Class
    
    
    Outstanding at November 6, 2003Common stock, $5.00 par value
    
    
    6,257,624 1     PALMETTO
            BANCSHARES, INC.Table of ContentsPage No.PART I.  FINANCIAL INFORMATION
          3Item 1.
          Financial Statements
          3Item 2.
          Management's Discussion and Analysis of Financial
            Condition andResults of Operations
          13Item 3.
          Quantitative and Qualitative Disclosures about Market
            Risk
          34Item 4.
          Controls and Procedures
          36PART II.  OTHER INFORMATION
          37Item 1.
          Legal Proceedings
          37Item 2.
          Changes in Securities and Use of Proceeds
          37Item 3.
          Defaults Upon Senior Securities
          37Item 4.
          Submission of Matters to a Vote of Security Holders
          37Item 5.
          Other Information
          37Item 6.
          Exhibits and Reports on Form 8-K
          37SIGNATURES
          38
 2     PART 1. FINANCIAL INFORMATION Item 1. Financial Statements PALMETTO BANCSHARES, INC.Consolidated Balance
  Sheets(in thousands, except share
      data)September 30,
    
    December 31,2003
    
    2002
    
    2002(unaudited)ASSETSCash and due from banks
    
    
    $        32,898
    
    40,120
    
    32,608Federal funds sold
    
    
    24,745
    
    29,840
    
    5,485Federal Home Loan Bank (FHLB) stock, at cost
    1,868
    
    1,733
    
    1,733Investment securities available for sale at fair
      value
    110,506
    
    97,074
    
    115,108Loans held for sale
    
    
    8,363
    
    8,747
    
    11,851Loans
    
    
    
    
    670,850
    
    599,594
    
    625,542Less allowance for loan losses
    
    (7,241)
    
    (6,252)
    
    (6,402)Loans, net
    
    
    663,609
    
    593,342
    
    619,140Premises and equipment, net
    
    
    21,378
    
    19,726
    
    19,715Accrued interest receivable
    
    
    3,880
    
    4,535
    
    4,146Other assets
    
    
    
    15,527
    
    14,104
    
    15,206Total assets
    
    
    $     
      882,774
    
    809,221
    
    824,992LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
    
    
    $      118,710
    
    113,887
    
    114,573Interest-bearing
    
    
    648,771
    
    590,333
    
    607,418Total deposits
    
    
    767,481
    
    704,220
    
    721,991Securities sold under agreements to repurchase
    15,373
    
    17,314
    
    12,831Commercial paper (Master notes)
    
    
    21,750
    
    16,226
    
    14,839Other liabilities
    
    
    7,766
    
    5,314
    
    7,810Total liabilities
    
    
    812,370
    
    743,074
    
    757,471Shareholders' equityCommon stock - par value $5.00 per share; 
    authorized10,000,000 shares; issued and outstanding 6,256,624,
      6,303,778and 6,324,659 at September 30, 2003 and 2002 and
      December31, 2002, respectively.
    
    
    31,283
    
    31,519
    
    31,623Capital surplus
    
    
    244
    
    84
    
    50Retained earnings
    
    
    37,967
    
    32,577
    
    34,173Accumulated other comprehensive income, net of
    tax
    910
    
    1,967
    
    1,675Total shareholders' equity
    
    70,404
    
    66,147
    
    67,521Total liabilities and shareholders' equity
    $     
      882,774
    
    809,221
    
    824,992See accompanying notes to consolidated interim financial
      statements.
 3     PALMETTO BANCSHARES,
  INC.Consolidated Statements of
      Income(in thousands, except share
      data)For the three
      months ended September 30,2003
    
    2002(unaudited)Interest incomeInterest and fees on loans
    
    
    $     10,633
    
    $     10,584Interest and dividends on investment securities
      available for saleU.S. Treasury and U.S. Government agencies
    179
    
    470State and municipal
    
    
    409
    
    412Mortgage-backed securities
    
    102
    
    89Interest on federal funds sold
    
    
    48
    
    96Dividends on FHLB stock
    
    
    17
    
    22Total interest income
    
    11,388
    
    11,673Interest expenseInterest on deposits, including retail repurchase
      agreements
    2,641
    
    2,946Interest on federal funds purchased
    8
    
    --Interest on commercial paper (Master notes)
    28
    
    44Total interest expense
    
    2,677
    
    2,990Net interest income
    8,711
    
    8,683Provision for loan losses
    
    
    900
    
    1,200Net interest income after provision for loan
    losses
    7,811
    
    7,483Noninterest incomeService charges on deposit accounts
    
    2,196
    
    2,052Fees for trust and brokerage services
    
    701
    
    576Mortgage banking income
    
    
    219
    
    85Gains on sales of investment securities
    
    81
    
    114Other
    
    
    
    
    673
    
    615Total noninterest income
    
    3,870
    
    3,442Noninterest expenseSalaries and other personnel
    
    
    3,992
    
    3,854Net occupancy
    
    
    582
    
    563Furniture and equipment
    
    
    884
    
    698Postage and supplies
    
    
    318
    
    397Marketing and advertising
    
    
    195
    
    180Telephone
    
    
    
    
    186
    
    204Cardholder processing
    
    
    138
    
    132Other
    
    
    
    1,294
    
    1,384Total noninterest expense
    
    7,589
    
    7,412Income before income taxes
    4,092
    
    3,513Income tax provision
    
    
    1,235
    
    1,184Net income
    
    $     
      2,857
    
    2,329Share Data:Net income - Basic
    
    
    $        0.46
    
    0.37Net income - Diluted
    
    
    0.45
    
    0.36Book value
    
    
    11.25
    
    10.49Weighted average common shares outstanding -
    Basic
    6,273,780
    
    6,301,974Weighted average common shares outstanding -
      Diluted
    6,370,340
    
    6,469,441See accompanying notes to consolidated interim financial
      statements.
 4     PALMETTO BANCSHARES,
  INC.Consolidated Statements of
      Income(in thousands, except share
      data)For the nine months ended September 30,2003
    
    2002(unaudited)Interest incomeInterest and fees on loans
    
    
    $     32,127
    
    $     31,409Interest and dividends on investment securities
      available for saleU.S. Treasury and U.S. Government agencies
    893
    
    1,218State and municipal
    
    
    1,182
    
    1,545Mortgage-backed securities
    
    492
    
    327Interest on federal funds sold
    
    
    111
    
    307Dividends on FHLB stock
    
    
    60
    
    72Total interest income
    
    34,865
    
    34,878Interest expenseInterest on deposits, including retail repurchase
      agreements
    8,134
    
    9,289Interest on federal funds purchased
    19
    
    1Interest on commercial paper (Master notes)
    80
    
    115Total interest expense
    
    8,233
    
    9,405Net interest income
    26,632
    
    25,473Provision for loan losses
    
    
    2,700
    
    3,100Net interest income after provision for loan
    losses
    23,932
    
    22,373Noninterest incomeService charges on deposit accounts
    
    6,417
    
    5,859Fees for trust and brokerage services
    
    2,053
    
    1,839Mortgage banking income
    
    
    305
    
    457Gains on sales of investment securities
    
    362
    
    349Other
    
    
    
    
    1,996
    
    1,864Total noninterest income
    
    11,133
    
    10,368Noninterest expenseSalaries and other personnel
    
    
    11,794
    
    11,210Net occupancy
    
    
    1,691
    
    1,672Furniture and equipment
    
    
    2,536
    
    2,002Postage and supplies
    
    
    1,123
    
    1,107Marketing and advertising
    
    
    632
    
    710Telephone
    
    
    
    
    557
    
    594Cardholder processing
    
    
    412
    
    420Other
    
    
    
    3,932
    
    4,179Total noninterest expense
    
    22,677
    
    21,894Income before income taxes
    12,388
    
    10,847Income tax provision
    
    
    3,921
    
    3,578Net income
    
    $     
      8,467
    
    7,269Share Data:Net income - Basic
    
    
    $        1.34
    
    1.15Net income - Diluted
    
    
    1.32
    
    1.12Book value
    
    
    11.25
    
    10.49Weighted average common shares outstanding -
    Basic
    6,315,334
    
    6,294,386Weighted average common shares outstanding -
      Diluted
    6,410,952
    
    6,464,048See accompanying notes to consolidated interim financial
      statements. 5     PALMETTO BANCSHARES, INC.Consolidated Statements of Changes in
      Shareholders' Equity and Comprehensive Income(in
      thousands, except share data) (unaudited)AccumulatedShares of
    
    
    
    othercommon
    Common
    Capital
    Retained
    comprehensivestock
    stock
    surplus
    earnings
    income,
      net
    TotalBalance at December 31,
      2001
    6,283,623
    $   31,418
    26
    27,386
    238
    59,068Net income
    
    
    
    
    7,269
    
    7,269Other comprehensive income,
      net of tax:Net unrealized holding gains (losses) arising duringperiod, net
      of tax effect of $1,217
    
    
    
    
    
    1,944Less:  reclassification adjustment for gains includedin net
      income, net of tax effect of $134
    
    
    
    
    (215)Net unrealized gains (losses) on securities
    
    
    
    
    
    1,729Comprehensive income
    
    
    
    
    
    
    8,998Cash dividend ($.11 per
      share)
    
    
    
    (2,078)
    
    (2,078)Stock option activity
    
    20,155
    101
    58
    
    
    159Balance at September 30, 2002
    
    6,303,778
    $  
      31,519
    84
    32,577
    1,967
    66,147Balance at December 31,
      2002
    6,324,659
    $   31,623
    50
    34,173
    1,675
    67,521Net income
    
    
    
    
    8,467
    
    8,467Other comprehensive income,
      net of tax:Net unrealized holding gains (losses) arising duringperiod, net
      of tax effect of $340
    
    
    
    
    
    (542)Less:  reclassification adjustment for gains includedin net
      income, net of tax effect of $140
    
    
    
    
    (223)Net unrealized gains on securities
    
    
    
    
    
    (765)Comprehensive income
    
    
    
    
    
    
    7,702Cash dividend ($.12 per
      share)
    
    
    
    (2,273)
    
    (2,273)Stock repurchase activity
    
    (100,000)
    (500)
    
    (2,400)
    
    (2,900)Stock option activity
    
    31,965
    160
    194
    
    
    354Balance at September 30, 2003
    
    6,256,624
    $  
      31,283
    244
    37,967
    910
    70,404 6     PALMETTO BANCSHARES, INC.Consolidated Statements of Cash Flow(in
      thousands)For the nine months ended September 30,2003
    
    2002(unaudited)Cash flows from operating activitiesNet income
    
    
    $      8,467
    
    7,269Adjustments to reconcile net income to net cash
      provided by (used in) operating activitiesDepreciation and amortization
    4,134
    
    1,358Gain on sale of investment securities
    (362)
    
    (349)Provision for loan losses
    2,700
    
    3,100Origination of loans held for sale
    (113,755)
    
    (65,546)Sale of loans held for sale
    117,548
    
    67,417Gain on sale of loans
    (305)
    
    (564)Change in accrued interest receivable
    266
    
    412Change in other assets
    (1,304)
    
    (1,295)Change in other liabilities, net
    436
    
    (291)Net cash provided by operating activities
    17,825
    
    11,511Cash flows from investing activitiesPurchase of investment securities available for
      sale
    (67,353)
    
    (50,123)Proceeds from maturities of investment securities
      available for sale
    13,078
    
    23,202Proceeds from sale of investment securities
      available for sale
    32,144
    
    24,039Principal paydowns on mortgage-backed securities
      available for sale
    24,693
    
    3,696Purchase of Federal Home Loan Bank stock
    (135)
    
    --Net increase in loans outstanding
    (47,846)
    
    (50,351)Purchases of premises and equipment, net
    (2,980)
    
    (1,857)Net cash used in investing activities
    (48,399)
    
    (51,394)Cash flows from financing activitiesNet increase in deposit accounts
    45,490
    
    58,920Net increase in securities sold under agreements
      to repurchase
    2,542
    
    2,001Net increase in commercial paper
    6,911
    
    5,150Proceeds from issuance of common stock
    354
    
    159Repurchase of common stock
    (2,900)
    
    --Dividends paid
    
    (2,273)
    
    (2,078)Net cash provided by financing activities
    50,124
    
    64,152Net increase in cash and cash
    equivalents
    19,550
    
    24,269Cash and cash equivalents at beginning
      of the period
    38,093
    
    45,691Cash and cash equivalents at end of the
      period
    $    57,643
    
    69,960Supplemental InformationCash paid during the period for:Interest expense
    
    $      8,308
    
    9,733Income taxes
    
    
    3,637
    
    3,555Supplemental schedule of non-cash
      investing and financing transactionsChange in unrealized gain on investment securities
      available or sale, pre-tax
    $      (1,245)
    
    2,811Loans transferred to other real estate owned
    677
    
    2,072Loans charged -off
    1,995
    
    2,689See accompanying notes to consolidated interim financial
      statements. 7     Palmetto Bancshares, Inc.
Notes To Consolidated Interim Financial Statements 1.  GENERAL Principles of
Consolidation and Nature of Operations The foregoing
unaudited consolidated financial statements include accounts of Palmetto
Bancshares, Inc. (defined collectively with its subsidiaries as the "Company"),
its wholly owned subsidiary, The Palmetto Bank (the "Bank"), and Palmetto
Capital, Inc. ("Palmetto Capital"), the Bank's wholly owned
subsidiary. The Bank provides a full range of banking services including, but
not limited to, taking deposits and making loans. Palmetto Capital offers the
brokerage of stocks, bonds, mutual funds and unit investment trusts. Palmetto
Capital also offers advisory services and variable rate annuities. The
Company's primary market area is the upstate of South Carolina. In management's
opinion, all significant intercompany accounts and transactions have been
eliminated, and all adjustments necessary for a fair presentation of the
results for interim periods presented have been included.  Any such adjustments are of a normal and
recurring nature. The Company operates as one business segment. Assets held by
Palmetto Bancshares or its subsidiary in a fiduciary or agency capacity for
customers are not included in the consolidated financial statements as such
items do not represent assets of Palmetto Bancshares or its subsidiary. Basis of Presentation The unaudited
consolidated interim financial statements are presented in accordance with the
instructions for Form 10-Q.  Accordingly,
certain information and footnotes required by generally accepted accounting
principles for complete financial statements are not included.  The interim statements should be read in
conjunction with the financial statements and footnotes thereto included in
Palmetto Bancshares' Annual Report on Form 10-K for the year ended December 31,
2002. Summary of
Significant Accounting Policies The significant
accounting policies used by the Company for interim reporting are consistent
with the accounting policies followed for annual financial reporting as
described in Note 1 to the Palmetto Bancshares' Annual Report on Form 10-K for
the year ended December 31, 2002.  There
have been no changes in these policies subsequent to the year ended December
31, 2002. Accounting Estimates
and Assumptions The accounting and
reporting policies of the Company conform to accounting principles generally
accepted in the United States of America and to general practices within the
banking industry. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities as of the dates of the consolidated balance sheets for the
periods presented. In addition, they affect the reporting amounts of income and
expense during the reporting period as of the dates of the consolidated
statements of income for the periods presented. Actual results could differ
from these estimates and assumptions. 
As such, the results of operations for the three months ended September
30, 2003 are not necessarily indicative of the results of operations that may
be expected in future periods. Risks and
Uncertainties In the normal course
of its business the Company encounters two significant types of risk: economic
and regulatory. There are three main components of economic risk: interest rate
risk, credit risk and market risk. The Company is subject to interest rate risk
to the degree that its interest-bearing liabilities mature or reprice at
different speeds, or on different bases, than its interest-earning assets.
Credit risk is the risk of default on the Company's loan portfolio that 8     results
from borrowers' inability or unwillingness to make contractually required
payments. Market risk reflects changes in the value of collateral underlying
loans, the valuation of real estate held by the Company and the valuation of
mortgage loans held for sale, investments and mortgage-backed securities
available for sale and mortgage servicing rights. The Company is
subject to the regulations of various government agencies. These regulations
can and do change significantly from period to period. The Company also
undergoes periodic examinations by the regulatory agencies, which may subject
it to further changes with respect to asset valuations, amounts of required
loss allowances and operating restrictions resulting from the regulators'
judgments based on information available to them at the time of their
examinations. Reclassifications Certain amounts
previously presented in the consolidated financial statements for prior periods
have been reclassified to conform to current classifications. All such
reclassifications had no effect on the prior years' net income or shareholders'
equity as previously reported. Website Availability
of Reports Filed with the Securities and Exchange Commission The Company's website,
www.palmettobank.com, includes a link to the Securities and Exchange
Commission's Electronic Data Gathering, Analysis, and Retrieval ("EDGAR")
system which makes various reports filed with the
Securities and Exchange Commission, including its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Ownership Reports
filed in conjunction with Section 16, and amendments to such reports,
available, free of charge.  These
reports are made available as soon as reasonably practicable after these
reports are filed with, or furnished to, the Securities and Exchange
Commission.  The Securities and Exchange
Commission's EDGAR database may also be accessed through its website,
www.sec.gov. 2.       PER
SHARE INFORMATION Basic and diluted
earnings per share have been computed based on net income in the accompanying
consolidated statements of income divided by the weighted average common shares
outstanding or assumed to be outstanding as summarized below: For the three months ended September 30,2003
    2002BASICAverage common shares outstanding
    (denominator)
    6,273,780
    6,301,974DILUTEDAverage common shares outstanding
    6,273,780
    6,301,974Dilutive potential common shares
    96,560
    167,467Average diluted shares outstanding
      (denominator)
    6,370,340
    6,469,441For the nine months ended September 30,2003
    2002BASICAverage common shares outstanding
    (denominator)
    6,315,334
    6,294,386DILUTEDAverage common shares outstanding
    6,315,334
    6,294,386Dilutive potential common shares
    95,618
    169,662Average diluted shares outstanding
    (denominator)
    6,410,952
    6,464,048
 Option shares are
excluded from the calculation of diluted earnings when the exercise price is
greater than the average market price of the common shares.  At September 30, 2003 there were no option
shares that were excluded from the calculation of diluted earnings due to the
exercise price being greater than the average market price of the common shares
as of that date, based on information available to the Company at that time. 9     3.       INTANGIBLE
ASSETS The table set forth below illustrates the activity of intangible assets with
finite lives, which are comprised of customer list intangibles, presented in
"other assets" in the consolidated balance sheets, and the related
amortization, presented in "other noninterest expense" in the
consolidated statements of income, for the years noted (in thousands). For the three months ended September 30,2003
    2002Balance, at beginning of period
    $   537
    668Amortization
    36
    30Balance, at end of period
    $   501
    638For the nine months ended September 30,2003
    2002Balance, at beginning of period
    $   608
    727Amortization
    107
    89Balance, at end of period
    $   501
    638
 The table set forth below illustrates the activity of intangible assets with
infinite lives, presented in "other assets" in the consolidated
balance sheets, and the related amortization, presented in "other
noninterest expense" in the consolidated statements of income, for the
years noted (in thousands). For the nine months ended September 30,2003
    2002Balance, at beginning of period
    $  3,691
    3,691Amortization
    ----
    ----Balance, at end of period
    $  3,691
    3,691
 The goodwill for each reporting unit will be tested for impairment as of
December 31, 2003 in accordance with SFAS No. 142, "Goodwill and Other
Intangible Assets," and such analysis will be updated annually. The Company estimates
that its amortization expense related to intangibles with finite lives in
fiscal years 2003 through 2009 will range from $144 thousand to $33 thousand. 4.      MORTGAGE
SERVICING RIGHTS Capitalized mortgage servicing rights ("MSRs") totaled $2.2
million, $2.1 million and $2.0 million at September 30, 2003, December 31, 2002,
and September 30, 2002, respectively. Amortization expense for MSRs totaled $482
thousand and $242 thousand for the three months ended September 30, 2003 and
2002, respectively.  Amortization expense for MSRs totaled $1.4 million and
$601 thousand for the nine months ended September 30, 2003 and 2002,
respectively.  Amortization expense for MSRs for the twelve months ended
December 31, 2002 totaled $946 thousand. Amortization expense is based on
current information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and other environmental factors. Prepayments could increase as a
result of any further decline in market interest rates, leading to an increase
in amortization expense.  There was no impairment adjustment to MSRs for
the three months ended September 30, 2003 nor for the three months ended
September 30, 2002.  The impairment adjustments to MSRs for the nine months
ended September 30, 2003 and 2002 were $133 thousand and $44 thousand,
respectively.  The impairment adjustment to MSRs for the twelve months
ended December 31, 2002 totaled $44 thousand. A valuation allowance for
impairment totaling $246 thousand was required at September 30, 2003, increasing
from a valuation allowance of $113 thousand required at September 30,
2002.  The valuation allowance for impairment required at December 31, 2002
totaled $113 thousand. 10     5.      STOCK-BASED
COMPENSATION At September 30, 2003, Palmetto Bancshares had a stock-based compensation
plan, which was described more fully in Note 12 of the Notes To Consolidated
Financial Statements included in Palmetto Bancshares' Annual Report on Form 10-K
for the year ended December 31, 2002. The Company accounts for this plan under
the recognition and measurement principles of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Key Company employees and Company
directors are eligible to participate in the stock awards plan. No stock-based
compensation cost has been reflected in net income, as all stock options granted
under these plans had an exercise price equal to the fair market value of the
underlying common stock on the date of grant. The table set forth below
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," to stock-based compensation (in thousands,
except share data). 11     For the three months ended September 30,2003
    2002Net income, as reported
    $  2,857
    2,329Deduct: Total stock-based employee and director
      compensation expense determined under fair value based methods for all
      awards, net of related tax
      effects
    35
    34Pro forma net income
    $  2,822
    2,295Earnings per shareBasic - as
      reported
    $  .46
    .37Basic - pro forma
    .45
    .36Diluted - as reported
    $  .45
    .36Diluted - pro forma
    .44
    .35
 For the nine months ended September 30,2003
    2002Net income, as reported
    $  8,467
    7,269Deduct: Total stock-based employee and director
      compensation expense determined under fair value based methods for all
      awards, net of related tax
      effects
    95
    118Pro forma net income
    $  8,372
    7,151Earnings per shareBasic - as
      reported
    $  1.34
    1.15Basic - pro forma
    1.33
    1.14Diluted - as reported
    $  1.32
    1.12Diluted - pro forma
    1.31
    1.11
 12     Item 2.  Management's
Discussion and Analysis of Financial Condition and Results of Operations The following
discussion and analysis is presented to assist in understanding the financial
condition and results of operations of Palmetto Bancshares, Inc.  This discussion should be read in
conjunction with the consolidated financial statements and related notes and
other financial data appearing in this report as well as the Annual Report of Palmetto
Bancshares, Inc. on Form 10-K for the year ended December 31, 2002.  Results of operations for the three months
ended September 30, 2003 are not necessarily indicative of results that may be
attained for any other period. 
Percentage calculations contained herein have been calculated based upon
actual, not rounded, results. Palmetto Bancshares was organized in 1982 under the laws of
South Carolina. Through its wholly-owned subsidiary, The Palmetto Bank, and the
Bank's wholly-owned subsidiary, Palmetto Capital, Inc., the Company engages in
the general banking business in the upstate South Carolina market of Laurens,
Greenville, Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, and Oconee
counties (the "Upstate").  The Bank was
organized and chartered under South Carolina law in 1906. The Bank performs a full range of banking activities,
including such services as checking, savings, money market, and other time
deposits of various types of consumer and commercial depositors; loans for
business, real estate, and personal uses; safe deposit box rental and various
electronic funds transfer services.  The
Bank also offers both individual and commercial trust services through its
trust department.  Palmetto Capital is a
brokerage subsidiary of the Bank, which offers customers stocks, treasury and
municipal bonds, mutual funds and insurance annuities, and college and
retirement planning. FORWARD
LOOKING STATEMENTS This report contains
certain forward-looking statements (as defined in the Private Securities
Litigation Reform Act of 1995) to assist in the understanding of anticipated
future operating and financial performance, growth opportunities, growth rates,
and other similar forecasts and statements of expectations. These
forward-looking statements reflect current views, but are based on assumptions
and are subject to risks, uncertainties, and other factors, which may cause
actual results to differ materially from those in such statements. These
factors include, but are not limited to, the following:         
risks from changes in economic, monetary
policy and industry conditions;
        
changes in interest rates, deposit
rates, the net interest margin and funding sources;
        
market risk and inflation;
        
risks inherent in making loans,
including repayment risks and value of collateral;
        
loan growth;
        
the adequacy of the allowance for loan
losses and the assessment of problem loans;
        
the Company's ability to meet its
contractual obligations;
        
fluctuations in consumer spending;
        
competition in the banking industry and
demand for the Company's products and services;
        
dependence on senior management;
        
level, 
composition,  and repricing  characteristics of the securities portfolio;
        
technological changes;
        
ability to increase market share;
        
expense projections;
        
risks associated with income taxes,
including the potential for adverse adjustments;
        
changes in accounting policies and
practices;
        
costs and effects of litigation; and
        
recently-enacted or proposed
legislation.Should one or more of these risks or uncertainties
materialize, or should underlying assumptions 13     prove incorrect, actual results
may vary materially from those expected or projected. Any forward-looking
statements speak only as of the date on which they are made. The Company
undertakes no obligation to update any forward looking statement to reflect
events or circumstances after the date on which such statement is made to
reflect the occurrence of unanticipated events. In addition, certain statements
in future filings by the Company with the Securities Exchange Commission, in
press releases and in oral and written statements made by or with the approval
of the Company, which are not statements of historical fact, constitute
forward-looking statements. SIGNIFICANT ACCOUNTING POLICIES The Company considers its policies regarding its allowance
for loan losses to be its most critical accounting policy due to the
significant degree of management judgment exercised in relation to this
estimate. The Company has developed policies and procedures for assessing the
adequacy of the allowance, which requires a number of assumptions and estimates
with respect to its loan portfolio. The adequacy of
the allowance is analyzed on a monthly basis using an internal analysis model.
For purposes of this analysis, adequacy is defined as a level sufficient to
absorb probable losses in the portfolio. The Company's allowance model takes
into account factors such as the composition of the loan portfolio (including
risk grade classifications, based on an internally developed grading system),
historical asset quality trends (including, but not limited to, previous loss
experience ratios), and reviews of specific high risk sectors of the
portfolio.  Loans are graded at
inception and are reviewed on a periodic basis to ensure that assigned risk
grades are proper based on the definition of such classification. The value of
underlying collateral is also considered during such analysis.  These assessments may be impacted in future
periods by changes in economic conditions, the impact of regulatory
examinations, and the discovery of information with respect to borrowers, which
is not known to management at the time of the issuance of the consolidated
financial statements. 14     BALANCE SHEET REVIEWOverview Total assets
increased by $57.8 million, or 7.0%, at September 30, 2003 as compared with
December 31, 2002 and increased by $73.6 million, or 9.1%, at September 30,
2003 as compared with September 30, 2002. 
Liquid assets, which include cash, federal funds sold, and investments
available for sale, increased by $15.1 million, or 9.7%, at September 30, 2003
from December 31, 2002 and increased by $1.3 million, or 0.7%, at September 30,
2003 from September 30, 2002. Total liabilities increased $55 thousand, or
7.2%, at September 30, 2003 from December 31, 2002 and increased $69 thousand,
or 9.3%, at September 30, 2003 from September 30, 2002. Total shareholders'
equity increased $2.9 million, or 4.3%, at September 30, 2003 from December 31,
2002 and $4.3 million, or 6.4%, at September 30, 2003 from September 30, 2002. Securities At September 30, 2003, the Company's investment portfolio totaled $112.4
million compared with $116.8 million and $98.8 million at December 31, 2002 and
September 30, 2002, respectively.  This
represents a decrease of 3.8% from December 31, 2002 and a 13.7% increase from
September 30, 2002. The composition of the investment portfolio at September
30, 2003 was as follows: agencies 13%, municipalities 37%, and mortgage-backed
securities and other securities 50%. During the first nine
months of 2003, the Bank purchased $67.4 million of investment securities
(available for sale), $46.0 million of the investment portfolio matured or was
sold, resulting in a gain of $362 thousand, and $24.7 million was paid down on
mortgage-backed securities.  The
September 30, 2003 securities balance included $1.5 million in pre-tax
unrealized gains in the portfolio. During the first nine
months of 2002, the Bank purchased $50.1 million of investment securities
(available for sale), $47.3 million of the investment portfolio matured or was
sold, resulting in a gain of $349 thousand, and $3.7 million was paid down on
mortgage-backed securities.  The
September 30, 2002 securities balance included $3.2 million in pre-tax
unrealized losses in the portfolio. Loans At September 30,
2003, the Company had total loans outstanding, including mortgage loans held
for sale, of $679.2 million, which equaled 84% of total deposits, including
retail repurchase agreements and commercial paper, and 77% of total
assets.  Loans are the largest category
of the Company's earning assets and have generally produced higher yields than
other earning assets.  The Company's
loan portfolio consists principally of commercial loans, commercial real estate
loans, consumer loans, sales finance loans, and mortgage loans. Mortgage loans held
for sale were $8.4 million at September 30, 2003 compared with $11.9 million
and $8.7 million at December 31, 2002 and September 30, 2002,
respectively.  This represents a
decrease of 29.4% from December 31, 2002 and a decrease of 4.4% from September
30, 2002.  Because of the favorable
interest rate environment for mortgage loans and refinances, the Bank
originated approximately $139.3 million in mortgage loans during the first nine
months of 2003, with approximately 84% being sold during the same period.  Approximately $74.9 million in mortgage
loans were originated during the first nine months of 2002.  The Company originates the majority of its
loans in its primary market area located in Upstate South Carolina. Loans, net of
unearned income and excluding those mortgage loans held for sale, were $670.9
million at September 30, 2003 compared with $625.5 million and $599.6 million
at December 31, 2002 and September 30, 2002, respectively.  This represents increases of 7.2% from
December 31, 2002 and 11.9% from September 30, 2002. 15     See "Credit Quality" for additional discussion of loan
portfolio performance. Allowance for Loan Losses The adequacy of the
allowance is analyzed on a monthly basis. 
For purposes of this analysis, adequacy is defined as a level sufficient
to absorb probable losses in the portfolio. The Bank uses an allowance model
that takes into account loan risk grades, delinquency trends, and charge-off
ratios as well as loan growth. Assessing the adequacy of the allowance requires
considerable judgment. See "Significant Accounting Policies" for additional
discussion related to the allowance for loan losses.  Management's judgments are based on numerous assumptions about
current events, which management believes to be reasonable.  The allowance is subject to examination and
adequacy testing by regulatory agencies. The allowance for loan losses totaled $7.2 million at
September 30, 2003 compared with $6.4 million and $6.3 million at December 31,
2002 and September 30, 2002, respectively. 
This represents an increase of 13.1% from December 31, 2002 and 15.8%
from September 30, 2002.  Table 1
summarizes the changes in the allowance. Table 1Summary of Loan Loss and Recovery
      Experience(dollars in thousands)At and for the nine months ended 
      September 30,
    At and for the year
  ended2003
    2002
    December 31, 2002Allowance at beginning of period
    $  6,402
    5,658
    5,658Net charge-offs:Loans charged-off
    1,995
    2,689
    3,770Less: loans
      recovered
    134
    183
    2261,861
    2,506
    3,544Additions to reserves through provision
    2,700
    3,100
    4,288Allowance at end of period
    $   7,241
    6,252
    6,402Average loans excluding mortgage loans held for
      sale
    $651,687
    567,341
    577,949Loans, net of unearned, excluding mortgage loans held for
      sale
    670,850
    599,594
    625,542Net charge-offs as a % of average loans excluding mortgage
      loans held for sale (annualized, where applicable)
    0.38%
    0.59
    0.61Allowance as a % of loans, net of unearned, excluding
      mortgage loans held for sale
    1.08
    1.04
    1.02
 16     The allowance for loan losses as a percentage of loans,
excluding mortgage loans held for sale, increased to 1.08% at September 30,
2003 from 1.02% and 1.04% at December 31, 2002 and September 30, 2002,
respectively. During mid-1999 management noted deterioration in the performance
of the sales finance portfolio, resulting in increased charge-offs in 1999 and
2000. In the years since the discovery of the deterioration in the portfolio
and these heightened charge-offs, charge-off levels have declined. In 2001 net
charged-off loans declined $970 thousand from 2000.  Net charged-off loans in 2002 declined $282 thousand from 2001.
Annualized (where applicable) net charge-offs as a percentage of average loans
excluding mortgage loans held for sale have declined from .59% for the nine
months ended September 30, 2002 to .38% for the nine months ended September 30,
2003.  Additionally, the sales finance
portfolio has had relatively little growth with a balance of $16.2 million at
September 30, 2003, $14.7 million at December 31, 2002 and $14.8 million at
September 30, 2002. Net
charge-offs for the nine months ended September 30, 2003 totaled $1.9 million,
a decline from $2.5 million for the nine months ended September 30, 2002.  The majority of the decline in net
charge-offs over these periods was the result of a decline of $298 thousand in
the commercial and industrial loan category as well as a decline in the
installment loan category (excluding credit cards) of $773 thousand.  Offsetting these declines was an increase in
charge-offs related to loans secured by real estate of $272 thousand and a
slight increase in net charge offs related to the credit card portfolio.  The decrease in charge-off activity within
the commercial / industrial and installment portfolios can be attributed to the
low interest rates environment, which has led to increased consumer debt
incurrence and refinancing. 
Additionally, the decline in charge-off activity related to the
installment portfolio can also be attributed to the increased performance
related to the quality of the sales finance portfolio.  The increase in charge-offs related to loans
secured by real estate stems from the high levels of mortgages in the
foreclosure process. The rise in foreclosures paralleled increasing job losses
and personal bankruptcies in the first nine months of 2003. See "Credit Quality" for additional discussion of factors
contributing to the allowance for loan losses. Other Assets At September 30, 2003, other assets totaled $15.5 million
compared with $15.2 million and $14.1 million at December 31, 2002 and
September 30, 2002, respectively.  This
represents an increase of 2.1% from December 31, 2002 and 10.1% from September
30, 2002. At September 30, 2003, major components of other assets
included the Travelers Express reserve totaling $1.9 million, net mortgage
servicing rights totaling $1.9 million, pension plan assets totaling $2.9
million, other real estate owned totaling $1.9 million, and $4.2 million of
intangible assets. At December 31, 2002, major components of other assets
included the Travelers Express reserve totaling $1.9 million, net mortgage
servicing rights which totaled $2.0 million, pension plan assets totaling $2.4
million, other real estate owned totaling $2.5 million, and $4.3 million of
intangible assets. At September 30, 2002, large components contributing to the
balance of $14.1 million of other assets included the Travelers Express reserve
totaling $1.9 million, net mortgage servicing rights totaling $1.9 million,
pension plan assets totaling $2.1 million, other real estate owned totaling
$1.5 million, and $4.1 million of intangible assets. The recent favorable interest rate environment as well as
the addition of a mortgage loan originator has contributed to the increase in
the loan portfolio at September 30, 2003 from December 31, 2002 as well as
September 30, 2002.  As noted in the
"Loans" section above, originations of mortgage loans held for sale in the nine
months ended September 30, 2003 totaled $139.3 million.  Since loans are typically sold servicing
retained, the increase in loans originated results in increased additions to
the mortgage servicing rights portfolio. 
Amortization and impairment of the rights as well as loan 17     payoffs offset
these additions. Due to the low volume of properties within the other real
estate owned portfolio, the foreclosure of new property or the sale of an
existing property can cause the balance to fluctuate greatly on a monthly
basis.  The other real estate owned
portfolio is often reviewed in terms of lending relationships, which may
contain of more than one parcel of real estate.  During the first nine months of 2003, $677 thousand in property
additions were added to the portfolio while properties sales and recoveries
totaling $1.1 million were consummated. 
Write-downs taken subsequent to properties being transferred to the
other real estate owned portfolio and write-downs resulting from sales totaled
$99 thousand for the nine months ended September 30, 2003.  At September 30, 2003 the other real estate
owned portfolio totaled $1.9 million. 
At December 31, 2002 the other real estate owned portfolio totaled $2.5
million.  During the first nine months
of 2002, $2.1 million in property additions were added to the portfolio while
properties sales and recoveries totaling $648 thousand were consummated.  Write-downs taken subsequent to properties
being transferred to the other real estate owned portfolio and write-downs
resulting from sales totaled $168 thousand for the nine months ended September
30, 2002.  At September 30, 2002 the
other real estate owned portfolio totaled $1.5 million. As noted above in the "Allowance for Loan Losses" section,
during mid-1999 management noted deterioration in the performance of the sales
finance portfolio. In the periods following these findings, charge-offs
increased and collateral was repossessed, in some cases, in conjunction with a
portion of these sales finance loans. Since this discovery and the related
charge-offs, the Bank has begun to experience a decrease in charge-offs (in part
related to this portfolio).  In
addition, the balance of repossessed automobiles has begun to decline.  Resulting from the review of the loans
within the portfolio, repossessed automobiles have declined from $337 thousand
at September 30, 2002 to $197 thousand at September 30, 2003.  Additionally growth within the sales finance
loan portfolio has been relatively stagnant during this time frame. See Note 3 of Notes To Consolidated Interim Financial
Statements contained herein for a summary of intangible assets. Deposits At September 30, 2003, traditional deposits totaled $767.5 million
compared with $722.0 million and $704.2 million at December 31, 2002 and
September 30, 2002, respectively.  This
represents an increase of 6.3% from December 31, 2002 and 9.0% from September
30, 2002.  Deposits remain the Bank's
primary source of funds for loans and investments.  Traditional deposits provided funding for 97% and 100% of average
earning assets for the nine months ended September 30, 2003 and 2002, respectively.The composition of the traditional deposit portfolio at
September 30, 2003 follows: time deposits 47%, interest-bearing demand deposits
32%, noninterest-bearing deposits 15%, and savings 6%. Borrowed Funds At September 30, 2003, total securities sold under agreement
to repurchase totaled $15.4 million compared with $12.8 million and $17.3
million at December 31, 2002 and September 30, 2002, respectively.  This represents an increase of 19.8% from
December 31, 2002 and a decrease of 11.2% from September 30, 2002. At September 30, 2003, total commercial paper totaled $21.8
million compared with $14.8 million and $16.2 million at December 31, 2002 and
September 30, 2002, respectively.  This
represents an increase of 46.6% from December 31, 2002 and 34.0% from September
30, 2002. 18     Other Liabilities At September 30, 2003, other liabilities totaled $7.8
million compared with $7.8 million and $5.3 million at December 31, 2002 and
September 30, 2002, respectively.  This
represents relatively no change from December 31, 2002 and an increase of 46.1%
from September 30, 2002. The increase in other liabilities at September 30, 2003
compared with September 30, 2002 of $2.5 million results from the fluctuations
in several accounts with the majority of the change accumulated within two
accounts. Taxes relating to the unrealized gain on available for sale
securities decreased approximately $662 thousand due to a decrease in the
unrealized gain on available for sale securities at September 30, 2003 from
September 30, 2002. The remaining increase in other liabilities between these
two periods relates primarily to increases in mortgage lending related
accounts.  The mortgage servicing
clearing account increased $3.1 million at September 30, 2003 from September
30, 2002.  When mortgage loans are sold,
funds are recorded in this account until all information is received for loan
system entry.  Once all items have been
received, the loan is booked on the loan system and the resulting funds are
simultaneously transferred from this clearing account to the proper loan
account.  Therefore, the volume of
mortgage loans held for sale, the timing of funding loans sold, and clearing
backlog impacts fluctuations in this account. Capital Resources and Dividends Shareholders' equity
totaled $70.4 million, $67.5 million, and $66.1 million at September 30, 2003,
December 31, 2002, and September 30, 2002, respectively.  Shareholders' equity as a percentage of
total assets was 7.98% at September 30, 2003, 8.18% at December 31, 2002 and
8.17% at September 30, 2002.  Increases
in shareholders' equity resulted from retention of earnings and stock option
exercises offset by dividends paid, decreases in unrealized gains in the
available for sale security portfolio, and the repurchase of 100,000 shares
during the third quarter of 2003. During May 2003 Palmetto Bancshares' Board of Directors
approved a stock repurchase transaction to acquire 100 thousand shares of
Common Stock.  During July 2003 the
transaction was consummated with Palmetto Bancshares repurchasing 100 thousand
shares at a cost of $29 per share. Book value per share
was $11.25 at September 30, 2003 compared with $10.68 and $10.49 at December
31, 2002 and September 30, 2002, respectively. As of September 30,
2003, the Company and the Bank were in compliance with each of the applicable
regulatory capital requirements and met or exceeded the "well-capitalized"
regulatory guidelines.  Table 2 sets
forth various capital ratios for the Company and the Bank.  The Company and the Bank are subject to
certain regulatory restrictions on the amount of dividends they are permitted
to pay. At September 30, 2003, the Bank had $2.4 million of excess
capital available for payment of dividends and still be considered
"well-capitalized" related to the total risk based capital ratio. 19     Table 2
Capital
Ratios As of9/30/03
   Adequately
   CapitalizedRequirement
   Well-CapitalizedRequirementCompany:Total Risk-based Capital
  10.36%
  8.00%
  10.00%Tier 1 Risk-based Capital
  9.32
  4.00
  6.00Tier 1 Leverage Ratio
  7.50
  4.00
  5.00Bank:Total Risk-based Capital
  10.35%
  8.00%
  10.00%Tier 1 Risk-based Capital
  9.31
  4.00
  6.00Tier 1 Leverage Ratio
  7.48
  4.00
  5.00  For a complete discussion of capital matters see related
topics in Palmetto Bancshares' Annual Report on Form 10-K for the year ended
December 31, 2002. Off-Balance Sheet
Arrangements The Company's off-balance sheet arrangements, which
principally include lending commitments, are described below. At September 30,
2003, December 31, 2002 and September 30, 2002, the Company had no interests in
non-consolidated special purpose entities. Neither Palmetto Bancshares nor the
Bank is involved in other off-balance sheet contractual relationships,
unconsolidated related entities that have off-balance sheet arrangements or
transactions that could result in liquidity needs or other commitments or
significantly impact earnings. Lending commitments include loan commitments, standby
letters of credit, and unused credit card lines. These instruments are not
recorded in the consolidated balance sheet until funds are advanced under the
commitments. The Company provides these lending commitments to customers in the
normal course of business. The Company applies essentially the same credit
policies and standards as it does in the lending process when making these
commitments. For commercial customers, loan commitments generally take
the form of revolving credit arrangements to finance customer's working capital
requirements. For retail customers, loan commitments are generally lines of
credit secured by residential property. Unused credit card lines are generally
used for short-term borrowings. At September 30, 2003, these commitments
totaled $128.0 million. Standby letters of credit represent an obligation of the
Company to a third party contingent upon the failure of the Company's customer
to perform under the terms of an underlying contract with the third party or
obligates the Company to guarantee or stand as surety for the benefit of the
third party.  The underlying contract
may entail either financial or nonfinancial obligations and may involve such
things as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or 20     repayment of an obligation.  Under the terms of a standby letter of
credit, generally, drafts will be drawn only when the underlying event fails to
occur as intended.  The Company can seek
recovery of the amounts paid from the borrower; however, standby letters of
credit are generally not collateralized. In recent months the Company has
reflected in its policy regarding such commitments that collateral is
encouraged with exceptions requiring approvals. Commitments under standby
letters of credit are usually for one year or less.  At September 30, 2003, the Company has recorded no liability for
the current carrying amount of the obligation to perform as a guarantor and no
contingent liability is considered necessary, as such amounts are not
considered material.  The maximum
potential amount of undiscounted future payments related to standby letters of
credit at September 30, 2003 was $2.0 million. 
Past experience indicates that many of these standby letters of credit
will expire unused. However, through its various sources of liquidity, the
Company believes that it has the necessary resources to meet these obligations
should the need arise.  Additionally,
current fair value of such guarantees are deemed immaterial at September 30,
2003. The table set forth below represents the Bank's issued
commitments to extend credit and unused credit card lines at September 30, 2003
(in thousands). Home equity loans
    $   27,063Credit cards
    37,928Commercial real estate development
    32,805Other unused lines of credit
    30,158Total unused commitment and unused credit card
      lines
    $ 
      127,954
 Generally, mortgage loan commitments are at adjustable rates
that fluctuate with prime rate or are at fixed rates that approximate market
rates. The current amounts of these commitments approximate their fair value
and are not deemed material. Liquidity Liquidity management
ensures that adequate funds are available to meet deposit withdrawals, fund
loan and capital expenditure commitments, maintain reserve requirements, pay
operating expenses, provide funds for dividends, and manage operations on an
ongoing basis.  Funds are primarily
provided by the Bank through customer deposits, principal and interest payments
on loans, loan sales, securities available for sale, maturities of securities,
and earnings. Proper liquidity
management is crucial to facilitate the Company's ability to take advantage of
new opportunities as well as meet the demands of its customers.  In this process, the Company focuses on
assets and liabilities and on the manner in which they combine to provide
adequate liquidity to meet the Company's needs. 
Investment securities are an important tool to the Company's liquidity
management.  Securities classified as
available for sale may be sold in response to changes in interest rates,
liquidity needs, and/or significant prepayment risk. 
Net cash provided by operations and deposits from customers have been the
primary sources of liquidity for the Company. 
Liquidity is also enhanced by the ability to acquire new deposits
through the Bank's established network of 30 branches in South Carolina. The Bank has access
to borrowings from the FHLB and maintains short-term lines of credit. At
September 30, 2003, the Bank had approximately $86 million of unused borrowing
capacity from the FHLB.  The Bank has
pledged assets to be used as collateral if the Bank takes advantage of the FHLB
line of credit.  At September 30, 2003,
the Bank had unused short-term lines of credit totaling approximately $37.0
million (which are withdrawable at the lender's option).  Management believes that these sources are adequate
to meet its liquidity needs and to maintain the liquidity ratio within policy
guidelines. 21     The Company's cash needs include general operating expenses and the payment of
dividends and interest on borrowings. 
The Company currently has no long-term debt outstanding and has declared
and paid cash dividends totaling $0.12 per share in the three months ended
September 30, 2003 and $0.36 per share in the nine months ended September 30,
2003.  Although there can be no
guarantee that additional dividends will be paid in 2003, the Company plans to
continue its quarterly dividend payments. In the normal course of business, to meet the financial
needs of its customers, the Company, principally through the Bank, enters into
agreements to extend credit. For amounts and types of such agreements at
September 30, 2003, see "Off-Balance Sheet Arrangements." Increased
demand for funds under these agreements would reduce the Company's liquidity
and could require additional sources of liquidity. Credit Quality A willingness to take credit risk is inherent in the
decision to grant credit. Prudent risk-taking requires a credit risk management
system based on sound policies and control processes that ensure compliance
with those policies. Adherence to underwriting standards is managed through a
multi-layered credit approval process and review of loans approved by lenders.
Through loan review, reviews of exception reports, and ongoing analysis of
asset quality trends, compliance with loan monitoring policies is managed. Table 3 presents information pertaining to nonperforming
assets. Table 3Nonperforming Loans and Assets(dollars in thousands)September 30,
    December 31,2003
    2002
    2002Nonaccrual loans
    $  5,180
    3,593
    2,500Total nonperforming loans
    5,180
    3,593
    2,500Other real estate owned
    1,919
    1,473
    2,468Repossessed automobiles
    197
    337
    181Total nonperforming assets
    $  7,296
    5,403
    5,149Loans past due 90 days and still accruing
(1)
    $    158
    277
    233Total nonperforming loans as a percentage of loans
      (2)
    .77%
    .60
    .40Total nonperforming assets as a percentage of loans, other
      real estate owned, and repossessed automobiles (2)
    1.08
    .90
    .82Allowance for loan losses as a percentage of nonperforming
      loans
    1.40x
    1.74
    2.56(1) Substantially all of these loans are credit card
      loans.(2) Calculated using loans, net of unearned, excluding
      mortgage loans held for sale.
 Similar to other
parts of the country, in recent years the markets served by the Company have
experienced a moderately slowing economy with higher bankruptcy filings and
higher delinquency rates.  Although
there have been signs of a recovery, the rise in foreclosures of the first nine
months of 2003 paralleled mounting job losses and personal bankruptcies.  Until sectors of the economy improve
(employment, consumer spending, etc), credit quality indicators will remain
volatile. While 22     current economic data seems to be signaling improvement, the
outlook remains uncertain. Other real estate owned increased $447 thousand at September
30, 2003 from September 30, 2002. This increase is attributed to several
properties acquired in settlement of loans that have not yet been sold due to
market conditions. Additionally, nonaccrual loans have increased $1.6 million
over the same time frame. Prior to recent times that have seen increased
bankruptcies and job losses, more flexibility was given for borrowers to make
payments when they became delinquent. Since that time, the Company has been
applying more strict collection policies to such loans.  The Company believes in most of these
nonaccrual loan cases, collateral is sufficient to cover any potential losses.
As a result, the Company has been more proactive in advancing loans to
nonaccrual status as a step toward foreclosure, and has ceased payment
negotiations that typically took place in the past. The Bank uses an allowance model that takes into account
loan risk grades, delinquency trends, and charge-off ratios as well as loan
growth. Assessing the adequacy of the allowance requires considerable judgment.
Management's judgments are based on numerous assumptions about current events,
which management believes to be reasonable. Management believes, however, that,
although the Company has seen an increase in both nonaccrual loans and other
real estate owned at September 30, 2003 from September 30, 2002, loss exposure
in the Company's loan portfolio is identified, adequately reserved in a timely
manner, and closely monitored to ensure that changes are promptly addressed in
its analysis of allowance adequacy. 
Accordingly, management believes the allowance as of September 30, 2003
is adequate, based on its assessment of probable losses, and available facts
and circumstances then prevailing. 
Additionally, management believes that there will always remain a core
level of delinquent loans and real estate and personal property acquired in
settlement of loans from normal lending operations.  To this end, long-term Bank goals include the management of
problem assets. 23     EARNINGS REVIEW COMPARISON OF THE
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2003
AND 2002 Overview Net income for the
three months ended September 30, 2003 totaled $2.9 million, up 22.7% compared
with $2.3 million for the third quarter of 2002. Earnings per diluted share for
third quarter 2003 were $0.45, a 25.0% increase from $0.36 per diluted share in
the third quarter 2002. Earnings per basic share for the third quarter 2003
were $0.46, a 24.3% increase from $0.37 per basic share for third quarter 2002. Average common shares
outstanding on a diluted basis were 6,370,340 for third quarter 2003, down 1.5%
from 6,469,441 for third quarter 2002. Average common shares outstanding on a
basic basis were 6,273,780 for third quarter 2003, down from 6,301,974 for
third quarter 2002. Net interest income after the provision for loan losses for the three months
ended September 30, 2003 and 2002 was $7.8 million and $7.5 million,
respectively, an increase of 4.4%. 
Noninterest income for the three months ended September 30, 2003 totaled
$3.9 million, up 12.4% compared with $3.4 million for third quarter 2002.
Noninterest expense for the three months ended September 30, 2003 increased
$177 thousand from the three months ended September 30, 2002. Net Interest Income Net interest income
is the difference between gross interest and fees on earning assets, primarily
loans and investment securities and interest paid on deposits and other
interest-bearing liabilities. The net interest margin measures how effectively
a company manages the difference between the yield on earning assets and the
rate paid on funds to support those assets. Fully tax-equivalent net interest
income adjusts the yield for assets earning tax exempt income to a comparable
yield on a taxable basis.  Table 4
presents average balance sheets and a net interest income analysis on a
tax-equivalent basis for the three months ended September 30, 2003 and 2002. Fully tax-equivalent net interest income for third quarter
2003 remained unchanged at $8.9 million when compared with the third quarter of
2002. The fully tax-equivalent net interest margin decreased to 4.34% in the
third quarter of 2003 from 4.93% in the third quarter of 2002. Average earning assets grew $98.2 million, or 13.7%, to
$813.0 million for third quarter 2003 from $714.9 million for third quarter of
2002, primarily from the growth of loans and investment securities offset by a
decline in federal funds sold. Average loans, including mortgage loans held for
sale, were $682.0 million for third quarter 2003 compared with $591.3 million
for third quarter 2002. Average investment securities, including the average
net unrealized securities gains, increased from $98.9 million for third quarter
of 2002 to $109.3 million for third quarter 2003. Average interest-bearing traditional deposits increased from
$562.3 million for third quarter 2002 to $638.5 million for third quarter 2003.
Average other interest-bearing liabilities increased to $36.9 million for third
quarter 2003 from $35.6 million for third quarter 2002. 24     Table 4Comparative
      Average Balance - Yields and Costs(dollars in
      thousands)For the three months ended September
      30,2003
    
    2002Average
      Balance
    Income
      /
      Expense
    Yield /
      Rate
    
    Average
      Balance
    Income
      /
      Expense
    Yield
      /
      RateASSETSInterest-earning
      assetsFederal fund
    $      
      19,536
    $        
      48
    0.97
    %
    $    
      22,551
    $       
      96
    1.69
    %Federal Home Loan Bank stock and
      deposits
    2,181
    17
    3.09
    
    2,082
    22
    4.19Nontaxable investment securities
      (2) (3)
    39,323
    584
    5.89
    
    36,177
    615
    6.74Taxable investment securities (2)
    69,945
    281
    1.59
    
    62,697
    559
    3.54Loans, net of unearned (1)
    682,038
    10,633
    6.19
    
    591,345
    10,584
    7.10Total interest-earning assets
    813,023
    11,563
    5.64
    
    714,852
    11,876
    6.59Noninterest-earning
      assetsCash and due from banks
    27,249
    
    
    
    28,847Allowance for loan losses
    (6,990)
    
    
    
    (6,000)Premises and equipment, net
    20,188
    
    
    
    19,785Accrued interest
    3,829
    
    
    
    4,378Other assets
    15,504
    
    
    
    13,071Total noninterest-earning assets
    59,780
    
    
    
    60,081Total assets
    $    
      872,803
    
    
    
    $   774,933LIABILITIES AND
      SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
      liabilitiesDemand deposits
    $    
      248,020
    $       
      244
    0.39
    %
    $  
      226,162
    $     
      421
    0.74
    %Savings
    43,015
    36
    0.33
    
    38,386
    65
    0.67Time
    
    347,479
    2,342
    2.67
    
    297,734
    2,412
    3.21Total interest-bearing deposits
    638,514
    2,622
    1.63
    
    562,282
    2,898
    2.04Other interest-bearing
      liabilities
    36,868
    55
    0.59
    
    35,552
    92
    1.03Total interest-bearing
      liabilities
    675,382
    2,677
    1.57
    
    597,834
    2,990
    1.98Noninterest-bearing
      liabilitiesNoninterest-bearing deposits
    116,559
    
    
    
    105,313Other noninterest-bearing
      liabilities
    10,504
    
    
    
    6,353Total noninterest-bearing
      liabilities
    127,063
    
    
    
    111,666Total liabilities
    802,445
    
    
    
    709,500Shareholders' equity
    70,358
    
    
    
    65,433Total liabilities and
      shareholders' equity
    $    
      872,803
    
    
    
    $   774,933NET INTEREST MARGIN
      (FTE)
    
    $    
      8,886
    4.34
    %
    
    $   
      8,886
    4.93
    %Tax-equivalent
      adjustment (3)
    
    $       
      175
    
    
    
    $      
      203(1)
    Nonaccrual loans are included in
      average balances for yield computations.  The effect of foregone
      interest incomeas a result of loans on
      nonaccrual was not considered in the above analysis.  All loans and
      deposits are domestic.(2)
    The average balances for
      investment securities include the unrealized gain or loss recorded for
      available for sale securities.(3)
    The tax-equivalent adjustment to
      net interest income adjusts the yield for assets earning tax-exempt incometo a comparable yield on a
      taxable basis.  Yields on nontaxable securities are stated on a fully
      taxable equivalentbasis, assuming the effective
      rate for the respective period.  The adjustments made to convert
      nontaxable investments to a fullytaxable
      equivalent basis were $175 and $203 for the 2003 and 2002 periods,
      respectively. 25     The underlying factor for the changes in the yields and
rates on earning assets and costing liabilities has been the action of the
Federal Reserve Open Market Committee during the past 33 months. From January
2001 through September 2003, the Federal Reserve cut interest rates 5.50%.  Variable rate loans typically repriced
immediately following changes in interest rates by the Federal Reserve. During
third quarter 2003 as compared with third quarter 2002, the net interest margin
declined primarily from decreasing yields of the loan and securities portfolios
which was a direct result of the interest rate environment only partially
offset by repricing certificates of deposits at lower rates.   The weighted average yield of the loan
portfolio decreased from 7.10% for third quarter 2002 to 6.19% for third
quarter 2003. The weighted average yield of the securities portfolio decreased
from 4.71% for third quarter 2002 to 3.14% for third quarter 2003.   As the Company reduced its interest rates
during the year, the decline in the earning asset yield outpaced the decline in
the funding source rate. Provision for Loan
Losses The allowance for
loan losses is increased by charges to current period operations, through the
provision for loan losses, when, based on the Company's allowance model, the
balance is deemed insufficient to absorb probable losses in the portfolio at
the balance sheet date.  The
provision for loan losses was $900 thousand for third quarter 2003 as compared
with $1.2 million for third quarter 2002. The provision is adjusted each month
to reflect loan volume growth and allow for loan charge-offs, recoveries
and other factors that impact management's assessment of the adequacy of the
allowance for loan losses.  Management's
objective is to maintain the allowance for loan losses at an adequate level to
cover probable losses in the portfolio. 
Additions to the allowance for loan losses are based on management's
evaluation of the loan portfolio under current economic conditions, past loan
loss experience, and such other factors, which in management's judgment deserve
recognition in estimating loan losses. During mid-1999 management noted deterioration in the
performance of the sales finance portfolio that resulted in increased
charge-offs during 1999 and 2000. Higher charge-offs in this portfolio
contributed to the increase in the provision for loan losses in recent years.
However, annualized third quarter net charge-offs as a percentage of average
loans excluding mortgage loans held for sale have begun to decline and were
..41% for the quarter ended September 30, 2003 compared with .56% for the
quarter ended September 30, 2002.  This
decline in charge-offs affects historical charge-off ratios, which are factors
within the Company's allowance model. See "Allowance for Loan Losses" for
discussion of such factors and their effects on the allowance for loan losses
and the provision for loan losses. While
management uses the best information available to make evaluations, future
adjustments to the allowance in the form of provisions through the income
statement may be necessary if economic conditions differ substantially from the
assumptions used in making the evaluation. 
The allowance for loan losses is subject to periodic evaluation by
various regulatory authorities and may be subject to adjustment, based upon
information that is available to them at the time of their examination. Noninterest Income
and Expense Noninterest income
for third quarter 2003 increased $428 thousand, or 12.4%, to $3.9 million from
$3.4 million for third quarter 2002. 
Noninterest expense for third quarter 2003 increased $177 thousand, or
2.4%, to $7.6 million over third quarter 2002. Major contributors to the increase in noninterest income for
the three months ended September 30, 2003 from the same period ended 2002 were
increases in service charges on deposit accounts totaling $144 thousand, fees
for trust and brokerage services totaling $125 thousand, and mortgage banking
income totaling $134 thousand.  Large
contributors to the fluctuation within the mortgage banking income financial
statement line item include an increase in gain on mortgage loan sales of $303
thousand over the two periods offset by an increase in mortgage servicing
rights amortization of $240 thousand when comparing the same periods.  The increase in mortgage servicing rights
amortization is based on several factors including, but not limited to, the
increased prepayment 26     speeds attributable to current market interest rates.  These fluctuations within the mortgage
banking income financial statement line item are attributable to the increased
originations and refinances of mortgage loans resulting from low mortgage loan
interest rates.  Should interest rates
increase, the level of originations and refinances of mortgage loans may
decline which may result in mortgage banking income being lower than recent
results. The increase within noninterest expense for the three months
ended September 30, 2003 from the three months ended September 30, 2002 was the
result of fluctuations in several accounts with the majority of the change
accumulated within two financial statement line items, salaries and other
personnel expense and furniture and equipment expense, which increased $138
thousand and $186 thousand, respectively for the three months ended September
30, 2003 from the same period ended September 30, 2002.  The increase in salaries and other personnel
expense for the three months ended September 30, 2003 compared with the same
period of 2002 is due to increased expenses during the third quarter of 2003
over that of 2002 related to the pension plan. The increase in furniture and
equipment expense is due to increased expense related to new item processing
hardware, software, and the related installations as well as new servicing
agreements entered into by the Bank related to the servicing of branch
equipment such as drive thru and ATM equipment. Income Taxes Income tax expense attributable to income from continuing
operations totaled $1.2 million for both the third quarter 2003 and the third
quarter 2002. The effective income tax rate was 30% for third quarter 2003 and
34% for third quarter 2002. 27     COMPARISON OF THE
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2003
AND 2002 Overview Net income for the
nine months ended September 30, 2003 totaled $8.5 million, up 16.5% compared
with $7.3 million for the same period of 2002. Earnings per diluted share for
the nine months ended September 30, 2003 were $1.32, a 17.9 % increase from
$1.12 per diluted share in the same period of 2002. Earnings per basic share
for the nine months ended September 30, 2003 were $1.34, a 16.5% increase from
$1.15 per basic share for the same nine months of 2002. Average common shares
outstanding on a diluted basis were 6,410,952 for the nine months ended
September 30, 2003, down 0.82% from 6,464,048 for the same nine months of 2002.
For the nine months ended September 30, 2003 average common shares outstanding
on a basic basis were 6,315,334, up slightly from 6,294,386 for the first nine
months of 2002. Net interest income after the provision for loan losses for the nine months
ended September 30, 2003 and 2002 was $23.9 million and $22.4 million,
respectively, an increase of 7.0%. 
Noninterest income for the nine months ended September 30, 2003 totaled
$11.1 million, up 7.4% compared with $10.4 million for the first nine months of
2002. Noninterest expense for the nine months ended September 30, 2003
increased $783 thousand from the nine months ended September 30, 2002. Net Interest Income Net interest income
is the difference between gross interest and fees on earning assets, primarily
loans and investment securities and interest paid on deposits and other
interest-bearing liabilities. The net interest margin measures how effectively
a company manages the difference between the yield on earning assets and the
rate paid on funds to support those assets. Fully tax-equivalent net interest
income adjusts the yield for assets earning tax exempt income to a comparable
yield on a taxable basis.  Table 5
presents average balance sheets and a net interest income analysis on a
tax-equivalent basis for the nine months ended September 30, 2003 and 2002. Fully tax-equivalent net interest income for the first nine
months of 2003 increased $954 thousand, or 3.6%, to $27.2 million from $26.2
million for the first nine months of 2002. The fully tax-equivalent net
interest margin decreased to 4.60% for the first nine months of 2003 from 4.99%
for the first nine months of 2002. Average earning assets grew $88.5 million, or 12.6%, to
$791.0 million for the first nine months of 2003 from $702.5 million for the
first nine months of 2002, primarily from the growth of loans and investment
securities offset by a decline in federal funds sold. Average loans, including
mortgage loans held for sale, were $664.5 million for the first nine months of
2003 compared with $574.9 million for same period of 2002. Average investment
securities, including the average net unrealized securities gains, increased
from $101.4 million for the first nine months of 2002 to $110.9 million for the
same period of 2003. Average earning traditional deposits increased from $558.1
million for first nine months of 2002 to $623.9 million for first nine months
of 2003. Average other interest-bearing liabilities increased to $35.7 million
for the nine months ended September 30, 2003 from $33.0 million for the same
period of 2002. 28     Table 5Comparative
      Average Balance - Yields and Costs(dollars in
      thousands)For the nine months ended September
      30,2003
    
    2002Average
      Balance
    Income
      /
      Expense
    Yield /
      Rate
    
    Average
      Balance
    Income
      /
      Expense
    Yield
      /
      RateASSETSInterest-earning
      assetsFederal fund
    $    
      13,451
    $        
      111
    1.10
    %
    $    
      24,182
    $       307
    1.70
    %Federal Home Loan Bank stock and
      deposits
    2,153
    60
    3.73
    
    2,057
    72
    4.68Nontaxable investment securities
      (2) (3)
    35,894
    1,738
    6.47
    
    44,614
    2,306
    6.91Taxable investment securities (2)
    74,987
    1,385
    2.47
    
    56,769
    1,545
    3.64Loans, net of unearned (1)
    664,506
    32,127
    6.46
    
    574,896
    31,409
    7.30Total interest-earning assets
    790,991
    35,421
    5.99
    
    702,518
    35,639
    6.78Noninterest-earning
      assetsCash and due from banks
    27,670
    
    
    
    28,449Allowance for loan
      losses
    (6,968)
    
    
    
    (5,817)Premises and equipment, net
    19,965
    
    
    
    19,666Accrued interest
    4,124
    
    
    
    4,499Other assets
    15,695
    
    
    
    12,300Total noninterest-earning assets
    60,486
    
    
    
    59,097Total assets
    $   
      851,477
    
    
    
    $   
      761,615LIABILITIES AND
      SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
      liabilitiesDemand deposits
    $   
      245,521
    $        
      855
    0.47
    %
    $   
      227,382
    $     1,293
    0.76
    %Savings
    41,399
    112
    0.36
    
    37,266
    193
    0.69Time
    
    336,989
    7,106
    2.82
    
    293,444
    7,664
    3.49Total interest-bearing deposits
    623,909
    8,073
    1.73
    
    558,092
    9,150
    2.19Other interest-bearing
      liabilities
    35,654
    160
    0.60
    
    33,031
    255
    1.03Total interest-bearing
      liabilities
    659,563
    8,233
    1.67
    
    591,123
    9,405
    2.13Noninterest-bearing
      liabilitiesNoninterest-bearing deposits
    112,629
    
    
    
    102,213Other noninterest-bearing
      liabilities
    8,892
    
    
    
    5,248Total noninterest-bearing
      liabilities
    121,521
    
    
    
    107,461Total liabilities
    781,084
    
    
    
    698,584Shareholders' equity
    70,393
    
    
    
    63,031Total liabilities and
      shareholders' equity
    $   
      851,477
    
    
    
    $   
      761,615NET INTEREST MARGIN
      (FTE)
    
    $    
      27,188
    4.60
    %
    
    $  26,234
    4.99
    %Tax-equivalent
      adjustment (3)
    
    $         
      556
    
    
    
    $      
      761(1)
    Nonaccrual loans are included in
      average balances for yield computations.  The effect of foregone
      interest incomeas a result of loans on
      nonaccrual was not considered in the above analysis.  All loans and
      deposits are domestic.(2)
    The average balances for
      investment securities include the unrealized gain or loss recorded for
      available for sale securities.(3)
    The tax-equivalent adjustment to
      net interest income adjusts the yield for assets earning tax-exempt incometo a comparable yield on a
      taxable basis.  Yields on nontaxable securities are stated on a fully
      taxable equivalentbasis, assuming the effective
      rate for the respective period.  The adjustments made to convert
      nontaxable investments to a fullytaxable
      equivalent basis were $556 and $761 for the 2003 and 2002 periods,
      respectively. 29     The underlying factor for the changes in the yields and
rates on earning assets and costing liabilities has been the action of the
Federal Reserve Open Market Committee during the past 30 months. From January
2001 through the end of September 2003, the Federal Reserve cut interest rates
5.50%.  Variable rate loans typically
repriced immediately following changes in interest rates by the Federal
Reserve. During the nine months ended September 30, 2003 as compared with the
same period of 2002, the net interest margin declined primarily from decreasing
yields of the loan and securities portfolios which was a direct result of the
interest rate environment only partially offset by repricing certificates of
deposits at lower rates. The weighted average yield of the loan portfolio
decreased from 7.30% for the nine months ended September 30, 2002 to 6.46% for
the same period of 2003. The weighted average yield of the securities portfolio
decreased from 5.08% for the nine months ended September 30, 2002 to 3.76% for
the same period of 2003.   As the
Company reduced its interest rates during the year, the decline in the earning
asset yield outpaced the decline in the funding source rate. Provision for Loan
Losses The allowance for loan losses is
increased by charges to current period operations, through the provision for
loan losses, when, based on the Company's allowance model, the balance is
deemed insufficient to absorb probable losses in the portfolio at the balance
sheet date.  The
provision for loan losses was $2.7 million for first nine months of 2003 as
compared with $3.1 million for the first nine months of 2002. The provision is
adjusted each month to reflect loan volume growth and allow for loan charge‐offs,
recoveries and other factors that impact management's assessment of the
adequacy of the allowance for loan losses. 
Management's objective is to maintain the allowance for loan losses at
an adequate level to cover probable losses in the portfolio.  Additions to the allowance for loan losses
are based on management's evaluation of the loan portfolio under current
economic conditions, past loan loss experience, and such other factors, which
in management's judgment deserve recognition in estimating loan losses. During mid-1999 management noted deterioration in the
performance of the sales finance portfolio that resulted in increased
charge-offs during 1999 and 2000. Higher charge-offs in this portfolio
contributed to the increase in the provision for loan losses in recent years.
However, annualized year-to-date net charge-offs as a percentage of average
loans excluding mortgage loans held for sale have begun to decline and were
..59% for the nine months ended September 30, 2002 compared with .38% for the
nine months ended September 30, 2003. 
This decline in charge-offs effects historical charge-off ratios, which
are factors within the Company's allowance model. See "Allowance for Loan
Losses" for discussion of such factors and their effects on the allowance for
loan losses and the provision for loan losses. Noninterest Income
and Expense Noninterest income
for the nine months ended September 30, 2003 increased $765 thousand, or 7.4%,
to $11.1 million from $10.4 million for the nine months ended September 30,
2002.  Noninterest expense for first
nine months of 2003 increased $783 thousand, or 3.6%, to $22.7 million at the
end of the nine months ended September 30, 2003. Major contributors to the increase in noninterest income for
the nine months ended September 30, 2003 from the same period ended 2002 were
increases in service changes on deposit accounts totaling $558 thousand, fees
for trust and brokerage services totaling $214 thousand, and other noninterest
income totaling $132 thousand. 
Offsetting these increases was a decline in mortgage banking income
totaling $152 thousand for the nine months ending September 30, 2003 compared
with the same nine months of 2002. 
Large contributors to the fluctuation within the mortgage banking income
financial statement line item include an increase in gain on mortgage loan
sales of $558 thousand over the two periods offset by an increase in mortgage
servicing rights amortization of $907 thousand when comparing the same
periods.  The increase in mortgage
servicing rights amortization is based on several factors including, but not
limited to, the increased prepayment speeds attributable 30     to current market
interest rates.  The increase in gains
on sales of loans during the first nine months of 2003 as well as higher levels
of gains in recent previous quarters are attributable to the increased
originations and refinances of mortgage loans resulting from low mortgage loan
interest rates.  Should interest rates
increase, the level of originations and refinances of mortgage loans may
decline which may result in gains on sales of mortgage loans being lower than
recent results. The
increase within noninterest expense for the nine months ended September 30,
2003 from the nine months ended September 30, 2002 was the result of
fluctuations in several accounts with the majority of the change accumulated
within three financial statement line items, salaries and other personnel
expense and furniture and equipment expense, offset by a decrease in other
noninterest expense.  Salaries and other
personnel expense increased $584 thousand during the nine months ended
September 30, 2003 compared with the same of period of 2002.  The increase in salaries and other personnel
expense for the nine months ended September 30, 2003 compared with the same
period of 2002 is due to increased staffing in various operational and retail
areas as well as annual raises. 
Furniture and equipment expense increased $534 thousand during the nine
months ended September 30, 2003 compared with the same of period of 2002.   The increase in furniture and equipment
expense is due to increased expense related to new item processing hardware,
software, and the related installations as well as new servicing agreements
entered into by the Bank related to the servicing of branch equipment such as
drive thru and ATM equipment. 
Offsetting these increases was a decrease in other noninterest expense
of $247 thousand when comparing the same periods.  This decline is due in most part to ceasing goodwill amortization
in accordance with SFAS No. 141 in the prior year and to decreases in legal
loan expenses resulting from the settlement of the Snyder lawsuit during the 4th
quarter of 2002.   For additional
information regarding this litigation, refer to disclosure in Palmetto
Bancshares' Annual Report on Form 10-K for the year ended December 31, 2002. Income Taxes Income tax expense attributable to income from continuing
operations increased to $3.9 million for the nine months ended September 30,
2003 from $3.6 million for same period of 2002. The effective income tax rate
was 32% for nine months ended September 30, 2003 and 33% for same period of
2002. 31     ACCOUNTING AND REPORTING MATTERS In November 2002, the FASB issued FASB Interpretation
("FIN") No. 45, "Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This Interpretation elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. This Interpretation does not prescribe a specific
approach for subsequently measuring the guarantor's recognized liability over
the term of the related guarantee. This Interpretation also incorporates,
without change, the guidance in FASB Interpretation No. 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others," which is being superseded. FIN
No. 45 requires that the initial recognition and initial measurement provisions
of the Interpretation be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. Disclosure requirements of the Interpretation
are effective for financial statements of interim or annual periods ending
after December 15, 2002. The Company adopted the initial recognition and
initial measurement provisions of FIN 45 effective as of January 1, 2003 and
adopted the disclosure requirements effective as of December 31, 2002. No
contingent liability was determined to be necessary relating to the Company's
obligation to perform as a guarantor, since such amounts are not considered
material. In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation Transition and Disclosure-an amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
adopted this standard effective December 31, 2002 and has included the required
disclosures in this Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003. As of September 30, 2003, the Company has not elected the
fair value treatment of stock-based compensation. Therefore, the adoption of
this standard had no impact on the financial position or the results of
operations of the Company. In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"),
which addresses consolidation by business enterprises of variable interest entities. Under FIN 46, an
enterprise that holds significant variable interest in a variable interest
entity but is not the primary beneficiary is required to disclose the nature,
purpose, size, and activities of the variable interest entity, its exposure to
loss as a result of the variable interest holder's involvement with the entity,
and the nature of its involvement with the entity and date the involvement
began. The primary beneficiary of a variable interest entity is required to
disclose the nature, purpose, size, and activities of the variable interest entity,
the carrying amount and classification of consolidated assets that are
collateral for the variable interest entity's obligations, and any lack of
recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. FIN 46 is effective for the first fiscal year or
interim period beginning after June 15, 2003. The impact to the Company upon
adoption is currently not known. In
April 2003, the FASB issued SFAS No. 149, "*Amendment
of Statement 133 on Derivative Instruments and Hedging Activities*." This
Statement amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement amends Statement 133 for decisions made
(1) as part of the Derivatives Implementation Group process that effectively
required amendments to Statement 133, (2) in connection with other Board
projects dealing with 32     financial instruments, and (3) in connection with
implementation issues raised in relation to the application of the definition
of a derivative, in particular, the meaning of an initial net investment that
is smaller than would be required for other types of contracts that would be
expected to have a similar response to changes in market factors, the meaning
of underlying, and the characteristics of a derivative that contains financing
components. The changes in this Statement improve financial reporting by
requiring that contracts with comparable characteristics be accounted for
similarly. This Statement is effective for contracts entered into or modified
after June 30, 2003, except as stated below and for hedging relationships
designated after June 30, 2003. In addition, except as stated below, all provisions
of this Statement should be applied prospectively. The provisions of this
Statement that relate to Statement 133 Implementation Issues that have been
effective for fiscal quarters that began prior to June 15, 2003, should
continue to be applied in accordance with their respective effective dates. In
addition, provisions of the statement which relate to forward purchases or
sales of when-issued securities or other securities that do not yet exist,
should be applied to both existing contracts and new contracts entered into
after June 30, 2003. At September 30, 2003, the Company has no embedded
derivative instruments.  The Company has
freestanding derivative instruments consisting of fixed rate conforming loan
commitments.  The commitments to
originate fixed rate conforming loans were not material at September 30, 2003.
The Company does not currently engage in hedging activities.  The Company adopted the provisions of SFAS
No. 149 on June 30, 2003, which had no impact on the financial position or
results of operations of the Company. In
May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances.) Many of
those instruments were previously classified as equity. SFAS No. 150 is
generally effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. In accordance with this Statement,
the Company adopted the provisions of SFAS No. 150, which did not have a
material impact on the financial position or results of operations of the
Company. In June 2003, the American Institute of Certified Public
Accountants (AICPA) issued an exposure draft of a
proposed Statement of Position (SOP), "Allowance for Credit Losses."
The proposed SOP addresses the recognition and measurement by creditors of the
allowance for credit losses related to all loans, as that term is defined in
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." The
proposed SOP provides that the allowance for credit losses reported on a
creditor's balance sheet should consist only of (1) a component for individual
loan impairment recognized and measured pursuant to FASB Statement No. 114 and
(2) one or more components of collective loan impairment recognized pursuant to
FASB Statement No. 5, "Accounting for Contingencies," and measured in
accordance with the guidance in the proposed SOP. The provisions of the proposed
SOP would be effective for financial statements for fiscal years beginning
after December 15, 2003, with earlier application permitted. The effect of
initially applying the provisions of the proposed SOP would be reported as a
change in accounting estimate.  Comments
on the exposure draft were due by September 19, 2003.  Although the effect on the financial position or results of operations of the Company related to the adoption of this proposed SOP
have not been determined, adoption is expected to have a material impact
on the Company. On October 8, 2003, The Financial Accounting Standards Board voted to
delay the effective date of FASB Interpretation No. 46 for one quarter, pushing
back the rule's effective date to reporting periods ending after Dec. 15, 2003. Other accounting standards that have been issued or proposed
by the FASB or other standards-setting bodies that do not require adoption
until a future date are not expected to have a material impact on the financial
position or the results of operations of the Company upon adoption. 33     Item 3.  Quantitative
and Qualitative Disclosures about Market Risk Market risk is the
risk of loss from adverse changes in market prices and rates.  The Company's market risk arises principally
from interest rate risk inherent in its lending, deposit, borrowing and
investing activities.  Management
actively monitors and manages its inherent rate risk exposure. Although the
Company manages other risks, such as credit quality and liquidity risk, in the
normal course of business, management considers interest rate risk to be its
most significant market risk. This risk could potentially have the largest
material effect on the Company's financial condition and results of
operations.  Other types of market
risks, such as foreign currency exchange rate risk and commodity price risk, do
not arise in the normal course of the Company's business activities. The Company's
profitability is affected by fluctuations in interest rates.  Management's goal is to maintain a reasonable
balance between exposure to interest rate fluctuations and earnings.  A sudden and substantial increase or
decrease in interest rates may adversely impact the Company's earnings to the
extent that the interest rates on interest-earning assets and interest-bearing
liabilities do not change at the same speed, to the same extent or on the same
basis.  The Company monitors the impact
of changes in interest rates on its net interest income using several tools. At
September 30, 2003, management believes that there have been no significant
changes in market risk as disclosed in Palmetto Bancshares' Annual Report on
Form 10-K for the year ended December 31, 2002. The
Bank's goal is to minimize interest rate risk between interest-bearing assets
and liabilities at various maturities through its Asset-Liability Management
("ALM").  ALM involves managing the mix
and pricing of assets and liabilities in the face of uncertain interest rates
and an uncertain economic outlook.  It
seeks to achieve steady growth of net interest income with an acceptable amount
of interest rate risk and sufficient liquidity.  The process provides a framework for determining, in conjunction
with the profit planning process, which elements of the Company's profitability
factors can be controlled by management. 
Understanding the current position and implications of past decisions is
necessary in providing direction for the future financial management of the
Company.  The Company uses an
asset-liability model to determine the appropriate strategy for current
conditions. Interest
sensitivity management is part of the asset-liability management process.  Interest sensitivity gap ("GAP") is the
difference between total rate sensitive assets and rate sensitive liabilities
in a given time period.  The Company's
rate sensitive assets are those repricing within one year and those maturing
within one year.  Rate sensitive
liabilities include insured money market accounts, savings accounts,
interest-bearing transaction accounts, time deposits and borrowings.  The profitability of the Company is
influenced significantly by management's ability to manage the relationship
between rate sensitive assets and liabilities. The
following table is a summary of the Company's one year gap (dollars in
thousands): September
      30,
      2003Interest-earning assets maturing or repricing within one
      year
    $ 368,921Interest-bearing liabilities maturing or repricing within
      one year
    331,527Cumulative gap
    $   37,394Gap as a percentage of total assets
    4.24 %
 The
above analysis does not take in to account any prepayments on mortgages,
consumer or other loans, or securities. 
All maturities are stated in contractual terms.  The Company's current GAP analysis reflects
that in periods of increasing or decreasing interest rates, rate sensitive
assets will reprice slower than rate sensitive liabilities. The Company's GAP
analysis also shows that at the interest repricing of one year, the Company's
net interest margin would be adversely impacted by an increase in market
interest rates. This analysis, however, does not take into account the dynamics
of the marketplace.  GAP is a static
measurement that assumes that if the prime rate increases by 1.00%, all 34     assets
and liabilities that are due to reprice will increase by 1.00% at the next
opportunity. Because
the Company's management feels that GAP analysis is a static measurement, it
manages its interest income through its asset/liability strategies that focus
on a net interest income model based on management's projections.  The Company has a targeted net interest
income range of plus or minus twenty percent based on a 3.00% change over
twelve months.   The asset/liability
committee meets weekly to address interest-pricing issues, and this model is
reviewed monthly.  Management will
continue to monitor its liability sensitive position in times of increasing
interest rates, which might adversely affect its net interest margin. 35     Item 4.  Controls and Procedures Under the
supervision and with the participation of the Company's management, including
the Chief Executive Officer and Chief Accounting Officer, the effectiveness of
the design and operation of the Company's disclosure controls and procedures
has been evaluated within 90 days of the filing date of this quarterly report,
and, based on such evaluation, our Chief Executive Officer and Chief Accounting
Officer have concluded that these controls and procedures are effective. There
were no significant changes in the Company's internal controls or in other factors
that could significantly affect these controls subsequent to the date of their
evaluation. Disclosure
controls and procedures are controls and procedures that are designed to ensure
that information required to be disclosed by the Company in the reports that
are filed or submitted under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities
and Exchange Commission's rules and forms. 
Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by
the Company in the reports that are filed or submitted under the Exchange Act
is accumulated and communicated to the Company's management, including the
Chief Executive Officer and Chief Accounting Officer, as appropriate to allow
timely decisions regarding required disclosure. 36     PART II.  OTHER
INFORMATION Item
1.  Legal Proceedings The Company is currently subject to various legal
proceedings and claims that have arisen in the ordinary course of its business.
In the opinion of management based on consultation with external legal counsel,
any reasonably foreseeable outcome of such current litigation would not
materially affect the Company's consolidated financial position or results of
operations. Item 2.  Changes in
Securities and Use of Proceeds None Item 3.  Defaults Upon
Senior Securities None Item 4.  Submission of
Matters to a Vote of Securities Holders None Item
5.  Other Information None Item
6.  Exhibits and Reports on Form 8-K (a)  Exhibits 31.1      L. Leon Patterson's Certification Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 31.2      Paul W. Stringer's Certification Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 32         Certifications Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 (b)  Reports on Form 8-K On October 17, 2003, the Company filed a Form 8-K announcing
the earnings release dated October 10, 2003, which included selected financial
data for the quarter ended September 30, 2003 and for select other previously
reported periods. On November 3, 2003, the Company filed a Form 8-K announcing
the mailing of its quarterly earnings overview to shareholders dated November
6, 2003, which included selected financial data for the quarter ended September
30, 2003 and for select other previously reported periods. 37    SIGNATURES Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized. PALMETTO BANCSHARES, INC. By: /s/      L. Leon
Patterson L. Leon Patterson Chairman and Chief
Executive Officer /s/      Paul W.
Stringer Paul W. Stringer President and Chief
Operating Officer (Chief Accounting Officer) Date:   November 14, 2003 38